Summary

U.S. executive pay is the highest in world. Part of this compensation comes from basic cash salaries and bonuses. While the bonus system can be abused, it is the incentive programs that create real problems. The main security used in the incentive program is the stock option. Stocks and options are used to try to align manager goals with shareholder goals. This is necessary because while the stockholders own the firm, the managers control it. This separation of ownership and control creates opportunities for managers to act in their own interest. Managers, academics , and boards of directors have argued that stock and option incentives reduce this conflict. We demonstrate that stock options also create other incentives that are not aligned with stockholder interests. Indeed, stock options may not even be an effective means of inducing better company performance.